The Mystery of The Blood Red Ledger

Something was poisoning the profits at Louise's Trattoria, and the new CEO didn't have long to find out what

In August 1997, after a 22-year career in the restaurant industry, Fred LeFranc finally got the call. An investor was buying Louise's Trattoria, a $22-million Italian-dining chain with 15 restaurants in the Los Angeles area. The investor wanted LeFranc as his CEO.

Louise's, which dished up homemade pastas, pizzas, and entrÉes, had won a following in ritzy Santa Monica, Beverly Hills, Brentwood, and Pasadena. But popularity had not translated into profitability. That's why the prospective owner wanted LeFranc. LeFranc's job: to pump up the struggling restaurants and expand.

The career move seemed tailor-made for LeFranc, who had helped grow a few companies in the past. The first was El Torito Restaurants in southern California, where he had worked for 10 years. Later he had served as chief operating officer at Una Mas, based in Palo Alto. In the latter position, he had helped expand the Mexican-food chain from 8 restaurants to 25 and had merged it with the Pollo Rey chain, doubling the size of the business.

Restaurants were in LeFranc's blood. He had dropped out of his pre-med studies at Chicago's Northwestern University at the age of 19, breaking the heart of his mother, who had emigrated from Mexico and dreamed that her son would become a doctor. He began waiting tables at the Chicago Hilton, eventually working the legendary Pump Room, where Frank Sinatra would show up at 1 a.m. with his entourage in tow and keep the joint hopping until dawn. LeFranc never looked back.

At age 41, LeFranc decided to take the top suite at Louise's, eager to grow a new company and try out in a small arena a raft of management theories he'd been testing for years. He got a 5% stake in the company, so he could eventually cash out in a sale or a merger. Plus, he'd be back in southern California, close to where his two teenage children were living.

On September 1, 1997, he moved into the main offices of Louise's, which were located far from the restaurants themselves, in a patch of cheap office space near an oil refinery in Torrance. Even before he could tour all the restaurants and shake the hands of his managers, the California State Board of Equalization froze the company's bank accounts, seeking $225,000 -- about three months' worth of overdue sales tax. Unable to write checks to suppliers on the frozen accounts, Louise's filed for Chapter 11 bankruptcy protection. It was LeFranc's ninth day on the job.

Unable to write checks to suppliers on the frozen accounts, Louise's filed for Chapter 11 bankruptcy protection. It was LeFranc's ninth day on the job.

He was shocked. "What did I get myself into? This was not part of the deal," LeFranc recalls thinking. Quickly, he called a meeting with his employees and reassured them that Louise's was still afloat. But over the next harrowing months, he delivered another message: In a company blindsided by surprises, Louise's would now follow a policy of truth telling. "And the truth is, we're fucking bankrupt," he told the workers. (When LeFranc is driving home a point, he gesticulates and you can hear the remnant of a Chicago accent.) Honesty would be a two-way street, he said. He would require the managers to be up-front about their operations, just as he would be about the company's finances. The approach was especially crucial at that point, because it was the only way to identify problems, correct them, and surmount the crisis, he said.

Then he hit the road to get credit terms restored with his suppliers.

LeFranc never says he felt betrayed or misled about the state of affairs he walked into. But he admits that like the rest of the employees, he didn't realize the depth of the chain's problems. He didn't know that the former managers had been using tax receipts to cover expenses. And there was a lot more he wouldn't learn -- until much later.

In the $376-billion restaurant industry, pretax income averages only 6%, according to the National Restaurant Association, the industry's main trade group. With unforgiving margins like those, making a go of any restaurant is a herculean effort. And the odds of turning around a bankrupt restaurant are slim. Against that backdrop, LeFranc was in for a fight against both time and hungry competitors. He had to cut losses and generate cash, let deadweight employees go and boost the morale of the people he would keep, and, finally, figure out how to lure customers back to the establishment. He would call upon two skills he'd learned over the years but had never tested in such a harsh environment: using technology to manage a business in maniacal detail and empowering workers to make decisions on their own. Although LeFranc had formidable experience, he had never had to tackle so many crises simultaneously -- and against such odds.

Louise's was founded in 1978 and grown by restaurateur Bill Chait, who acquired it seven years later. Chait, according to several people, had an almost instinctive grasp of the business, anticipating and riding the wave of the Italian-food craze that began in the late 1980s. Chait's brother, Jon, financed the chain's second restaurant; over the years, Bill Chait sought and received $14 million in venture capital and loans from Bank of America and Bankers Trust and used the money to expand the chain. But like many other restaurant organizations, Louise's found that undisciplined growth would be its undoing. "They started building restaurants and spending money faster than it was coming in," recalls Jon Chait.

Before LeFranc came aboard, Louise's had already closed four restaurants on the East Coast. LeFranc would eventually reduce the total number of restaurants to 13. But despite the chain's obvious problems, it already had its fans. "They had real strong attributes, like high-quality takeout years before it was the norm," says Jim Parish, a Dallas restaurant-investment consultant who advised one of Louise's investors in 1997, when the troubles surfaced. But Parish found the management team lacking. "You need to be aware of costs and build it into your daily discipline. None of that existed," he says.

Louise's had also followed a top-down management model in which employees were expected to do as they were told. LeFranc encountered that culture as soon as he visited the restaurants. "I used to ask the managers, 'What do you think should be done?" he says. "And they looked at me with an expression like, 'What's the right answer?' And I would say, 'No, really, what do you think?' They just weren't used to being asked that question."

In 1997, Jon Chait, who was then managing director of Manpower, thought Louise's was promising enough to buy it from his brother and the venture-capital investors, who held a 20% stake. He knew, though, that he would need a professional to take over for his brother, whom he describes as a passionate entrepreneur who was bored by managerial details. (Bill Chait declined to comment for this story.) Using a headhunter, he found LeFranc.

But things would hardly go as Jon Chait had planned. After Louise's filed for Chapter 11, the bankruptcy judge threw out Jon's deal to buy the company for $4.5 million. Instead, because there were other people interested in buying the chain, he ordered an auction. Jon ended up paying $7 million for Louise's, which added yet one more financial burden. Under the terms of the sale, which was completed in January 1998, when Louise's exited bankruptcy, Jon put up $3.5 million in cash and gave the creditors a note for another $3.5 million to satisfy their debts. The note paid the creditors principal and interest of about $68,000 a month, which would come out of Louise's already stretched coffers.

The huntIn his previous jobs, LeFranc -- an analytical man in any case -- had learned to rely on the grittiest of details. To run a successful restaurant, he believed, he needed to manage what to others might seem like minutiae: the frequency of supply deliveries, the way food is stored in the walk-in refrigerators, the unit costs of premade tomato sauce, seasonal-staffing schedules, targeted marketing promotions, guest counts, average check sizes, and the margins on a plate of food. But the former owners had measured few if any of those details. In the chaotic months after the bankruptcy filing, LeFranc had hardly any of the information he needed. He was flying blind.

To add to his troubles, accounts payable was in shambles, and his first chief financial officer quit shortly after the filing. In March 1998, LeFranc lured James McGehee, a controller he had worked with at Una Mas, to come aboard. On McGehee's first day as Louise's controller, a second CFO, on the job for just two weeks, walked into McGehee's office and wished him luck. He, too, was leaving.

McGehee, who suddenly became CFO, put a temp to work sorting out stacks of invoices left in the wake of the bankruptcy filing. "In the second week I was there, I caught a duplicate payment of $110,000," he says. He hired everyone he could find, including LeFranc's two kids, to help input the invoices. It took him three months to put together an earnings statement. Louise's was losing $157,000 every 28 days. But where were those losses coming from?

Although LeFranc couldn't immediately pinpoint the source of the bleeding, the more he dug, the more he learned. One early focus was the company's commissary, which imported olive oil, cheese, and other ingredients from Italy and then made sauces, salad dressings, and pastas by hand. The commissary was Louise's central-supply operation, selling its goods to the restaurants.

At first glance, the setup looked surprisingly healthy. The restaurants paid the commissary a price for supplies that left their food costs at 28% to 29% of revenues. "Then December comes rolling around, and the food costs jump to 50%," LeFranc says. "It's like my stomach goes into a knot."

And for good reason. He discovered that the commissary was selling supplies to the restaurants below cost and accumulating losses each month. Then, in December, to erase the $150,000 in losses it had built up all year, it would dramatically raise its prices.

Once he figured out what was going on, LeFranc priced the commissary's products at their true cost. The higher prices pushed up the restaurants' food costs to 35%, and all of a sudden operations didn't look so buoyant.

In May, LeFranc traveled to Italy to meet the suppliers that were at the root of those costs. "They treated us like kings. And I was very polite. I learned a lot, and as soon as I came back I said, 'OK, we're not going to do business with them anymore," he says.

He decided to outsource basic foodstuff -- sauces, dressings, and pastas -- to less expensive American companies, and he shut the commissary down. LeFranc also reduced distributors' deliveries to the restaurants from six to three days a week. With fewer deliveries, transport costs declined, and LeFranc was able to wring out better terms for supplies. The new delivery schedule also helped the accounts- payable department, since it meant fewer invoices, down to about 3,000 a year from 20,000. Finally, LeFranc moved the company's headquarters to West L.A. to be closer to the restaurants and, not incidentally, to cut his rent almost in half.

With the reengineering of supplies, deliveries, and eventually the menu, food costs fell more than 9 percentage points, to around 25.5% of revenues. By November 1998, 11 months after it had emerged from bankruptcy, Louise's was cash-flow positive.

Stopping the bloodletting was one thing. What was less clear was whether LeFranc could create a self-monitoring organization that could survive and grow.

The mapThe key to running such an organization was getting accurate information, which at the broadest level meant an income statement. But to get a really detailed plan that might guide the team forward, LeFranc and his managers would have to parse the profit-and-loss statement into hundreds of components and measure each individually. The cost of pizza dough, the wages of a new chef, the price of napkins -- all of it would need to be tallied for each restaurant, creating the detailed contours of an earnings map.

The problem with gathering that wealth of information, however, was that it could be expensive. And LeFranc's top-level staff was lean. He had cut headquarters by about 40%, down to just himself and seven administrators. He didn't like the top-down model anyway, since he felt it stifled initiative and had contributed to the company's troubles. Instead, he wanted managers to become de facto CEOs of their restaurants, using the information they collected to plan and measure their performance. LeFranc would reward the managers based on cash-flow results. For some, the bonuses would push a $55,000 annual salary up to $80,000.

To get his program running, LeFranc taught his team to not just read but also analyze an income statement, not something restaurant managers commonly do. He also put his managers through a time-management course designed by Stephen Covey, author of The Seven Habits of Highly Effective People, and had them set goals for both the company and their own careers. He trained the chefs as well, since they were responsible for food and labor costs in the kitchen. Many of them had worked their way up from entry-level dishwashing jobs. "We had to teach some of them how to use a calculator," says CFO McGehee.

Gazelle's software could find out where the customers lived and shopped and how much they earned and spent. LeFranc was blown away by the technology.

A few of his employees, however, welcomed the new regime. One of the bookkeepers at the former commissary was a young man named Roger Ortiz, a self-taught whiz at Excel spreadsheets. Impressed by Ortiz's work, LeFranc promoted him from his $10-an-hour job tracking food supplies and trained him as a financial analyst. With McGehee's help, Ortiz began crunching all the numbers that increasingly were letting LeFranc sleep well at night.

LeFranc provided all his managers with personal computers and DSL lines in the restaurants so they could feed data quickly to Ortiz. The managers began tallying revenues, expenses, and guest counts daily, entering the figures into spreadsheets. Each Monday morning they E-mailed the spreadsheets to Ortiz, who then imported the data into his master Excel files and created a report that ran to 40 pages. He broke out year-to-date figures for the entire company as well as for each restaurant, did comparisons between year-ago results and the company's plan, and charted the effect of marketing promotions. On Monday afternoon Ortiz would ship the report to all the managers. (LeFranc plans to have Ortiz post the reports to a shared server soon so that managers can access the reports without E-mailing them back and forth.)

The system of data sharing had some unintended but beneficial consequences. The managers at two of the biggest restaurants began competing hard against each other to post the highest results. And LeFranc started holding monthly meetings for all managers at which they explained their results to one another. All were accountable, most notably to their peers.

The welcome matThe burning question for the newly self-directed team, however, was whether it could ramp up sales in a company that had been tainted by bankruptcy. The task was particularly hard because of what LeFranc admits was a bad decision he had made early on -- keeping the company name. "I didn't go there because it was such a radical change," he says ruefully. So the team went forward with larger signs and a sporty logo featuring the tarnished moniker.

After the bankruptcy filing, the company's sales had dropped 8% to 10%. Then, in the fall of 1998, when LeFranc reduced the menu from 60 to 30 items to lower food costs, sales dropped another 7% within four months. (Since he had turned cash-flow positive during that time, he was sacrificing sales for profits.)

To get his customers back, LeFranc had to find out who they were. So he turned to Gazelle Systems, a Newton, Mass., company he had come across at an industry convention in 1997. It had just four employees at the time, but LeFranc was blown away by its technology. Gazelle could develop a demographic profile of the restaurants' customers -- where they lived, where they shopped, and how much they earned and spent. The software company could determine whether the customers were married or single, male or female, parents, or sports fans. It also could find out how frequently they visited Louise's and how much they spent. Although large retailers and catalog companies relied on such information, no one, to LeFranc's knowledge, had ever applied such data-mining technology to a restaurant.

Gazelle downloaded customer-purchase information from the restaurants' point-of-sale (POS) system and then matched it with in-depth demographic records in data banks that marketing companies offered for sale.

Gazelle's data helped LeFranc overhaul his marketing approach. With maps pinpointing where his customers lived, for example, he could target specific streets with promotional material. "Instead of doing a direct mail of 495,000 pieces, we door-dropped 20,000 pieces," LeFranc says. "For a third of the cost of the mailing I got double the response." The number of "trials," as new customers are called in the industry, rose.

The CEO had learned that 54% of his customers were women, which prompted him to put lighter fare on the menu -- salads, pastas with light sauces, and vegetarian dishes. He began to offer seafood dishes designed by a well-known Maui chef -- sea bass with white-bean tomato salad, and salmon on a bed of garlic mashed potatoes with pineapple-cilantro salsa. LeFranc calls such food "California Italian."

It also turned out that 60% of the restaurants' customers had children aged 8 to 16, and 30% of those parents were single -- and time strapped, LeFranc assumed. That meant a huge potential for the company's takeout business. To grow the chain's already substantial takeout trade, LeFranc had one of his managers set up a toll-free phone number that would detect where a customer was calling from. The system would route the call to the nearest Louise's location.

During the bankruptcy, "we never had time to focus on just sales building, as we can now," says the CEO. "We were always juggling priorities." With the team's full attention, sales grew 4.8% in the fourth quarter of 2000 and peaked with an 11.5% gain in December. In early 2001, sales rose another 6.7%.

When a guest sits down for a lunch of grilled swordfish over fettuccine with a piquant tomato sauce at a Louise's in West Los Angeles, all the elements that LeFranc has put together are in evidence. The food arrives quickly; the steaming fish is juicy. And the sauce -- whose tomato base is outsourced to a supplier -- tastes homemade. The CEO has reason to complain only when a waiter clears an appetizer plate and leaves a guest without a fork for the main course. It's a small point, but LeFranc notices it -- just as he notices everything else.

Ultimately, the triumphs of LeFranc's business are measured in tiny increments -- shave a percentage point on food costs, lift customer counts by 1% or 2%, get another $1.25 per average check, strive for three seatings a night instead of two. At some point, perhaps this year, LeFranc and his staff will have made all those changes. Revenues will be about as high as they can go, given the size of the restaurants, and margins will be healthy. Then Louise's can begin expanding once again -- but this time without disastrous results.

The difference now is that LeFranc, the detail man, will be in charge. He figures he can open up another five locations without adding corporate overhead, so cash flow from those new restaurants would pour straight to the bottom line. Owner Jon Chait is in favor of the plan. "It's hard to have a restaurant business that's standing still," he says.

In any industry, turnarounds are grueling. In the restaurant business, they're brutal. Without persistence, luck, and a bloodhound's attention to detail, they're fated to fail. LeFranc had all those things. So now he's finally back where he started -- ready for growth.

Anthony Bourdain, a professional chef and author of the best-selling memoir Kitchen Confidential: Adventures in the Culinary Underbelly, has run kitchens that were stunning successes and others that were dismal failures. He offered writer Samuel Fromartz his sobering advice on turnarounds.

Inc.: What's it like working for a failing restaurant? Does it resemble a house of cards falling, or is it more gradual?

Bourdain: It sucks. It's soul destroying in increments, particularly if you're proud of your own efforts there. I'd compare it less to a house of cards -- though many restaurants, if undercapitalized from the beginning are indeed that -- than to a progressive, lingering, painful, and disfiguring disease with occasional welcome, but ultimately meaningless, remissions. One's pride, love, hope, and self-image leach slowly into the bedpan along with the owner's money.

Inc.: Have you ever tried to resuscitate a bankrupt restaurant?

Bourdain: I have tried many, many times to resuscitate a dying restaurant. I've never succeeded, though I might have prolonged some death throes. I'd never do it again.

Inc.: What would you say to a true pro who thinks he can turn around a failed restaurant without changing the name?

Bourdain: I'd say good luck. I'm sure it can be done. It has been done. But the odds against it are enormous -- and it goes against all conventional wisdom to associate any bold new venture with a failed one. Most places try very hard to separate themselves in every way from any memory of the bad old days. The public is very unforgiving about certain cursed restaurant locations, some of which -- even though they are fabulous -- remain doomed for all who follow. The public hates the smell of failure. And the scent seems to linger from incarnation to incarnation. Can a seasoned pro pull it off? Like I said, good luck.

Inc.: Restaurants always die. What's the secret to longevity?

Bourdain: The secret to longevity is to decide early on what one does well and then do it relentlessly, fanatically well, never wavering, never letting things slide, never allowing oneself to lose sight of one's original standards and intentions, and not falling victim to trends or unreasonable fears. Keep the owner or chef -- whoever's got the marquee value -- on site always, or near to it. If the original famous chef leaves, immediately buy an even more famous one with his or her own style consistent with but different from the original. Lose David Wells? Buy Roger Clemens!

Inc.: What would you say to a restaurateur who describes his cuisine as California Italian designed by a Maui chef?

Bourdain: Cali-Italo-Luau? It sounds insane. It sounds loathsome. But then I am as knowledgeable of SoCal customs as I am of Dayak tribesmen, the Illuminati, or snake-handling cults. I'm still befuddled and appalled by Wolfgang Puck's pizzas -- so what do I know? Just keep that avocado away from my pasta, capisce?